A health savings account (HSA) may provide financial benefits both now and in the future. HSAs can not only be used to save pre-tax cash for qualified medical expenses, but they can also provide substantial retirement advantages. Here’s all you need to know about how an HSA works and how it differs from FSA.
What Is an HSA?
A Health Savings Account (HSA) is a tax-advantaged account set up for or by people who have high-deductible health plans (HDHPs) to save for eligible medical expenses. Contributions to the account are made by the individual or their employer and are limited to a certain amount each year. Contributions are invested and can be used to pay for qualified medical expenses such as medical, dental, and eye care, as well as prescription medicines.
How Does an HSA Work?
As previously stated, people with HDHPs can open HSAs. People with HDHPs may be eligible for HSAs, and the two are frequently combined. To be eligible for an HSA, the taxpayer must meet the Internal Revenue Service’s eligibility requirements (IRS). An eligible person is one who:
- Has a qualified HDHP
- Has no other health insurance
- Is not a Medicare beneficiary.
- Is not claimed as a dependent on the tax return of someone else
In 2022, the maximum HSA contribution for an individual is $3,650 ($3,850 in 2023) and $7,300 for a family ($7,750 in 2023). The yearly contribution restrictions apply to the total amount contributed by both the employer and the employee. People who are 55 or older by the end of the tax year can make an additional $1,000 catch-up contribution to their HSAs.
Some financial institutions can also open an HSA. Contributions must be made in cash, but employer-sponsored plans can be supported jointly by the individual and their employer. Any other person, such as a family member, can contribute to an eligible individual’s HSA. Those who are self-employed or jobless may also contribute to an HSA if they meet the eligibility conditions.
People who enroll in Medicare for the first time are no longer eligible to contribute to an HSA. They can, however, get tax-free distributions for eligible medical expenses, as explained below.
The Coronavirus Assistance, Relief, and Economic Security (CARES) Act of 2020 authorized the use of HSA money for over-the-counter drugs and certain other health-related products. Plan participants who are confused about which expenses qualify can consult their HSA administrator or a pharmacist.
What Is The Benefit Of An HSA?
A Health Savings Account (HSA) has numerous benefits, including:
- Money enters tax-free. Your HSA contributions are made pre-tax, resulting in immediate savings. Contributions to an HSA are also tax deductible.
- Money comes out tax-free. When the HSA is used, eligible healthcare purchases can be made tax-free. Purchases can be made directly from the HSA account, either by using a healthcare debit card (if one is included with your HSA), ACH, online bill-pay, or cheque, or by paying out of pocket and reimbursing yourself from your HSA.
- Earn tax-free interest. The interest earned on HSA savings is tax-free. Unlike other savings accounts, interest generated on an HSA is not taxable income when utilized for qualified medical costs.
- Your HSA balance can be carried forward from year to year. An HSA, unlike a flexible spending account (FSA), is not a “use it or lose it” account. Your balance can increase year after year.
- HSA funds can be invested. You may be able to invest your HSA in an interest-bearing account, a mutual fund, stocks, or bonds, depending on your HSA.
- You can utilize your HSA to supplement your retirement savings.—
- Beyond the age of 65, you can take funds from your HSA for any reason.
The Drawbacks of an HSA
The most obvious disadvantage is that you must qualify for an HDHP. Also, you must have a high-deductible plan, reduce insurance premiums, or be wealthy enough to afford the high deductibles and get the tax benefits.
People who finance their own HSAs, whether through payroll deductions or directly, should be able to set aside enough money to cover a significant percentage of their HDHP deductibles. People who do not have enough money to put aside in an HSA may find the high deductible amount difficult.
HSAs also have filing requirements for contributions, withdrawal rules, distribution reporting, and a record-keeping burden that may be difficult to maintain.
How Do I Open An HSA Account?
To open an HSA, contact your employer’s human resources department to see whether they have a relationship with or can recommend a financial institution that offers HSAs. Your insurance may also suggest or provide an HSA account.
HSAs are available from most major financial institutions, so you may be able to open one through your bank. Be sure you understand what fees if any, will be paid for account maintenance. Monthly administrative costs are not levied to Medical Mutual members who are registered in a QHDHP and choose the Medical Mutual HSA.
After enrolling in a qualified high-deductible health plan and deciding where you want to set up your account, you can finish the application procedure and fund the account.
What Can I Pay With an HSA?
HSAs can be used to cover a variety of medical expenses. The IRS has provided a partial list of qualifying medical expenses (based on IRS Section 213 and stated in Publication 502):
- Deductibles, copayments, and coinsurance in health insurance plans
- Prescribed medications
- Braces, bridges, and crowns
- Glasses and Lasik eye surgery
- Some psychological and psychiatric treatments
- Services for the elderly
- Transportation and lodging for medical purposes
- COBRA and other health-care premiums
HSA Contribution Guidelines
Contributions to an HSA are not required to be used or withdrawn within the fiscal year. They are instead vested, and any unused contributions can be carried forward to the following year. Furthermore, an HSA is transferable, which means that if people change employment, they can keep their HSAs.
An HSA plan can also be tax-free transferred to a surviving spouse upon the death of the account holder. If the chosen beneficiary is not the account holder’s spouse, the account is no longer considered as an HSA, and the beneficiary is taxed on the account’s fair market value, less any eligible medical expenditures paid from the account by the decedent within a year of death.
HSA vs FSA
Many people ask what the greatest approach to saving for health care expenditures is while selecting health coverage. Should they go with an HSA, or should they go with an FSA? Or perhaps a blend of the two?
Here’s a primer on HSAs and FSAs to help you decide which is best for you and your family.
HSA vs FSA: General Overview
Health savings accounts (HSAs) and flexible spending accounts (FSAs) both allow you to set money away for health care bills before it is taxed. Withdrawals are also tax-free if used to pay for eligible medical expenditures. This can help you have more money available to pay for medical expenditures.
Someone in the 22% federal income tax bracket, for example, might potentially save over 30% in taxes (federal income + FICA + maybe state income) on every dollar put to an FSA or HSA through payroll deductions.
Employers typically provide HSAs and FSAs as part of benefit packages, but you may be able to open an HSA on your own if you have an HSA-eligible health plan through employment, your spouse’s company, private insurance, or the insurance marketplace. In such situation, you’d be able to deduct any HSA payments you make from your annual tax return, albeit these contributions might not be tax-deductible for Medicare and Social Security.
HSA vs FSA: Key Differences
Aside from the commonalities, FSAs and HSAs differ in a few key ways:
#1. Unused HSA funds can be carried forward.
HSAs allow you to carry money forward indefinitely, ensuring that your assets are available year after year. This can make life easier if you contribute more than you can spend in a year—you won’t have to rush out to buy Band-Aids or spectacles before your money runs out. Yet, it is especially useful in saving for substantial, future medical bills, such as those you anticipate incurring in retirement.
Meanwhile, FSAs are often “use it or lose it.” This implies that when the new benefit year begins, you may lose any monies left in your account from the previous year. Some employers may permit you to carry forward a portion of your unused debt or may provide a grace period (normally up to 2.5 months). Check with yours to see whether you can carry over a portion of your FSA at the end of the fiscal year.
#2. You can put the money into your HSA.
Unlike an FSA, you can possibly grow the funds in your HSA by investing them. This allows you to structure your finances to take advantage of compound interest. When combined with the flexibility to carry over savings from year to year, you may be able to save for eligible medical expenses. According to the Fidelity Retiree Health Care Cost Estimate, an average retired couple age 65 may need around $315,000 saved (after-tax) to meet health care bills throughout their retirement by 2022.
You can invest as much or as little as you desire in your HSA. Some people invest their whole portfolio; others want to save some—or all—of their earnings for current costs. It’s your account, so make your choice.
Your work determines whether you can open an FSA; your health insurance determines if you can start an HSA.
You must be enrolled in an HSA-qualified health plan and have no other disqualifying health coverage to be eligible for an HSA. If you are unsure which type you have, contact your benefits provider. FSAs, on the other hand, are employer-provided benefits to which anyone can contribute if they are eligible and their company provides them.
HSA vs FSA: Can You Have Both?
You cannot finance any sort of FSA in the same year if you contribute to an HSA. An HSA can coexist alongside a limited-purpose FSA, sometimes known as an LPFSA. This sort of FSA only pays expenses that your health plan does not cover, such as dental and vision care.
An HSA may allow you to donate more than an FSA.
Both HSAs and FSAs have yearly contribution limits that are set by the IRS each year. Companies can set FSA restrictions for their plans as well.
In 2022, the maximum amount you can contribute to an HSA is $3,650 for individual coverage and $7,300 for family coverage. This increases to $3,850 for individual coverage and $7,750 for family coverage in 2023. Individuals aged 55 and up are eligible for a $1,000 catch-up contribution. The maximum contribution for FSAs in 2022 is $2,850, rising to $3,050 in 2023.
If your employer contributes to your HSA or FSA on your behalf, the amount you can contribute may be reduced.
Your HSA is yours, not your employer’s.
Your HSA (and everything inside it) is yours forever, even if you leave your work. If you are unemployed, you can even utilize HSA savings to cover COBRA costs and health insurance premiums. FSAs, on the other hand, are owned by your firm, albeit you may contribute to them with your own money. If you quit your work, you will forfeit all funds in your account.
You may be able to access your FSA funds earlier in the year. FSA monies are available to spend in full at the start of your plan year. Hence, if you opt to contribute $2,850 to your FSA, you will have the entire amount available to you on the first day your benefits begin.
Contributions to an HSA, on the other hand, accumulate only when you make them. If you expect to save $2,850 for the year, you may only have access to half of that amount by the end of June, making it difficult to fund major bills. HSAs, on the other hand, allows you to reimburse yourself for any qualified medical expenses, allowing them to function similarly to FSAs.
If you charge a $1,200 medical payment on your credit card since your HSA is insufficiently funded. You can repay yourself when your HSA balance is sufficient to cover the expenditure.
When you reach the age of 65, you can treat an HSA like a standard 401(k) or IRA.
To avoid a 20% penalty, plus any applicable taxes, spend funds in FSAs and HSAs solely for eligible medical expenses. But, beginning at the age of 65, the 20% penalty is abolished for HSAs, thereby making them similar to typical 401(k)s or individual retirement plans (IRAs). If you are 65 or older and opt to use HSA funds for ineligible expenses, you will still owe any relevant income taxes on the amount you withdraw.
HSA vs FSA: Which Is Better?
If you are eligible for both an HSA and an FSA, carefully analyze the benefits and drawbacks of each plan. The decision between FSA and HSA (or HSA plus limited purpose FSA) is based on your specific financial condition as well as the health of you and your family.
If you can’t choose between FSAs and HSAs because of your health plan or employer’s offerings, don’t stress about which account is best for you. HSAs and FSAs are both excellent ways to save money for eligible medical expenses.
Can You Withdraw Money From HSA?
Yes. You can take money out of your HSA at any time. But, if you use HSA funds for anything other than a qualified medical expense, the money will be taxed as ordinary income, and the IRS will levy a 20% penalty.
How Much Money IN HSA Is Enough?
Consider your medical history as well as the lifespan of your family. Utilize that data to set an HSA savings goal. If you’re calculating for you and your spouse, the figure should be between $150,000 and $1 million. If you’re only estimating for yourself, reduce the amount.
What Can I Buy With My HSA Card?
You can use your HSA to cover qualified medical, dental, and vision expenditures for yourself, your spouse, or eligible dependents (children, siblings, parents, and others who are considered an exemption under Section 152 of the tax code).
How Do I Spend My HSA Money?
You can use your HSA in a variety of ways. Pay for eligible medical bills with a swipe of your card at any time. Bills for eligible medical expenses are received and paid. Receive reimbursement for out-of-pocket medical expenses.
In Conclusion,
Overall, HSAs are among the strongest tax-advantaged savings and investment vehicles available under the United States tax code. Donations are not taxed, hence they are sometimes referred to as triple tax-advantaged..
Medical expenses tend to rise as a person ages, especially as they reach retirement age and beyond. As a result, if you qualify, creating an HSA early and letting it accrue over time can make a significant difference in protecting your financial future.
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